The Regulatory Challenges

Martin Walker

Guide the people by law, subdue them by punishment; they may shun crime, but will be void of shame. Guide them by example, subdue them by courtesy; they will learn shame, and come to be good.

– Confucius, The Analects

Attempting to guide the financial sector by example is probably the only regulatory approach that governments, central banks and regulators have not adopted. Prior to the global financial crisis (GFC), there were two major schools of regulatory thought: the detailed rule-based system found in the US, and the principle-based approach used in the UK. In retrospect, both seem to have largely failed in prudential regulation (regulations that attempt to maintain the stability of the financial system) and conduct of business regulation (which attempts to stop the financial sector from wrongdoing). Clearly, there were failings in both regulations and the regulators (not to mention the behaviour of many in the financial sector) leading up to the crisis, and this has generated what can best be described as a tsunami of regulation. Much of the activity of financial markets firms consists of data processing in complex, imperfect environments, so complying with